Would you pay $120 for shares valued at $100? Irrational as this financial decision may seem, some CEOs of U.S. companies are doing just that. A new study by Columbia Business School examines the behavior of CEOs when a looming proxy contest threatens their leadership, and finds that CEOs will almost always exercise their options out-of-the-money in order to boost their voting power.

"CEOs embroiled in a proxy contest are determined, even desperate, to retain control," said Wei Jiang, Arthur F. Burns Professor of Free and Competitive Enterprise at Columbia Business School and co-author of the research. "Our findings show that in the battle for the boardroom, CEOs will do whatever it takes to maintain or strengthen their voting rights, including halting sales of their shares, increasing option exercises in order to hold resulting shares, and even, in the most extreme cases, resorting to exercising options to acquire shares out-of-the-money."

The study, titled "Out-of-the-Money CEOs: How Do Proxy Contests Affect Insider Option Exercises," was co-authored by Jiang and Professor Vyacheslav Fos of the University of Illinois and a graduate from Columbia Business School's Ph.D. program.

The researchers examined the effects of proxy challenges on incumbent CEOs' behavior, as reflected in their option exercises.  To prove that changes in CEO option-exercise behavior was driven by proxy battles, Jiang and Fos also looked at activity surrounding the record date—the latest date by which to acquire shares to earn voting rights.

"Embattled CEOs are using their option exercises at the last minute as another weapon against increasingly aggressive shareholder activists," explained Jiang. "This calls into question the checks and balances that exist to allow board members and shareholders to oversee corporate governance."

Among the key findings of the research:

• When a proxy contest is looming, the rate at which CEOs sell their shares slows down by 80 percent, while the rate at which they hold shares accelerates by 60 percent—by keeping the shares, they also keep their votes.
• To avert takeover, CEOs facing a contest are three times as likely to exercise options out-of-the-money—an irrational strategy under conventional models. In these cases, CEOs' valuation of their stocks exceeds that of the market price by up to 20 percent.
• Irregular option-exercise behavior intensifies before the record date. To maximize voting rights, CEOs completely stop exercising and selling shares and quintuple their rate of exercising and holding shares before the record date. After the record date, CEOs start to exercise options to sell again, reverting back to normal exercise-and-hold rates.